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Money Market Basics

by: Douglas Gerlach

The moment you deposit money into an investment account, it starts to work for you. It doesn’t earn interest, as in a typical bank account, but it doesn’t just sit there either. Your cash is automatically "swept" into purchases of shares in something called a money market fund (sometimes known simply as a money fund).

Money Market Fund Explained

A money market fund is really a mutual fund. The money fund’s manager invests the fund’s assets in short-term bonds, providing a fairly safe and predictable return. Note that we said "fairly safe" – as with any investment, a money market is never completely risk-free, though they do come pretty close, since government bonds are the usual investment vehicle of choice for money market funds. Money market funds have failed in the past, though it’s quite rare for that to occur.

How Money Markets Work

The price of a single share of a money market fund is always constant at $1.00 a share. How then, you might ask, can you make money by investing in a money market? Because the money market invests in bonds, those bonds do pay a yield, which creates income for the money fund shareholders. That income is computed daily as dividends; those dividends are credited to your account on a monthly basis. (Most people think of these dividends as "interest," and that’s a fair comparison.) These dividends often add up to be a bit more than you get from a typical savings account at your bank, but the effective yield can vary from day to day and month to month.

If you are a ShareBuilder member who wants to make a purchase in your account, your money market fund is at your disposal. Your shares in the money market are sold and the cash is used to carry out your purchase. This all happens automatically, so you don’t have to do anything special – your money market is already considered to be part of your "cash balance."

Knowing how money market funds work is a small but important part of building a portfolio. But while money markets are great if you want to temporarily "park" some cash while you find a few good stocks, or to build up an emergency fund, you don’t want to let your money sit too long when it’s not working at its hardest for you. For long-term objectives, history has shown that stocks are almost always the best way to reach those goals.